British Central Banker Favors Splitting Big Banks

LANDON THOMAS Jr.

Wednesday

Jan 27, 2010 at 5:12 AM

An argument once seen as an academic debate is now gaining traction among policy makers.

LONDON — Mervyn A. King, the governor of the Bank of England, is an owlish, self-effacing man who, in contrast to his more outspoken peers in Frankfurt and Washington, strikes a public posture that borders on the demure.

But as outrage over lush banking profits gathers steam on both sides of the Atlantic, Mr. King finds himself at the vanguard of a growing movement that argues that big banks must separate their higher-risk trading and investment banking businesses from their core deposit-taking functions.

Last week, such a proposal pushed by the former Federal Reserve chairman Paul A. Volcker made headway. President Obama shocked Wall Street by proposing that large banks that collect customer deposits be banned from engaging in proprietary trading activities.

At a hearing before a parliamentary treasury committee on Tuesday, Mr. King used some of his strongest language yet to support such a separation. In the process, he hailed Mr. Obama for having moved so quickly.

“The U.S. has been more open in moving to a safer banking system than we are,” he said. “After you ring-fence retail deposits, the statement that no one else gets bailed out becomes credible.”

To illustrate his point that increased regulation and higher capital requirements alone would not be sufficient to forestall another banking crisis, he pointed to Citigroup — which once was seen as a model for combining all banking functions under one roof.

“You had regulators in the building and four of the most respected people in the world running the bank,” he said, citing its architect, Sanford I. Weill; the former Treasury secretary Robert E. Rubin; the former International Monetary Fund official Stanley Fischer; and a veteran international banker, William Rhodes.

“They did not set out to destroy Citibank, but when you have a large complicated institution, things happen,” he said. “That is the argument for trying to create firewalls.”

Under post-Depression laws, bank holding companies in the United States were not allowed to own investment banks before 1999. But in Europe, no such division ever existed.

In fact, until last week such a notion had been roundly criticized, more a provocative debating point in an academic seminar than a practicable piece of legislation. Others speculated that the idea would surely be swatted away by muscular banking lobbies if it ever came close to becoming law.

Indeed, some see the idea, far-fetched and steeped in principle as it may be, as more an emblem of Mr. King’s own unyielding sense of what is right and what is wrong for the markets — albeit one that in this case is in tune with the public mood.

“I think Mervyn is a little more fixated on moral hazard than others,” said DeAnne Julius, a prominent economist here, referring to the view that rescuing banks via bailouts or sharp cuts in interest rates just encourages more of the risky conduct that got them in trouble in the first place.

Ms. Julius, a former member of the central bank’s policy-making committee, disagrees with Mr. King’s bank proposal. But she acknowledged that “he believes strongly in the rigors of market discipline, and he has a tendency to stay with a theory and get the world to conform to it.”

Prime Minister Gordon Brown, who earlier fired his own cannonball at bankers with his proposal for 50 percent tax on bonuses, said on Tuesday that British banks were not in need of such a change.

Last month Robert Diamond Jr., the president of Barclays, which with its substantial trading business would be one of the banks most affected, gave a series of speeches defending the universal model.

“Banks are bound to fight,” Mr. King said in his testimony.

Mr. King’s arguments were delivered with a severity that reached beyond his view that banks that had become larger and more profitable since the crisis must be shrunk.

A former finance professor at the London School of Economics, Mr. King, 61, is known as a ferocious worker.

And in 2007, as central banks in the United States and Europe aggressively cut interest rates, Mr. King stubbornly kept British rates fixed, arguing that any such loosening would unfairly reward bad banking behavior.

After the failure of Northern Rock and the collapse of Lehman Brothers, Mr. King shifted course. The Bank of England has become perhaps the most aggressive central bank in terms of adding liquidity to the economy by buying government bonds.

But after this unprecedented action, Mr. King has become even more doctrinaire in his view that the large banks that have benefited be forced to pay a price, one that would ensure that they never again threaten the viability of the world financial system.

In his testimony, Mr. King said he had been thinking about how to address the dangers of big banking since 2007, at the first signs of the crisis.

But it was not until last June, during a speech before the financial industry, that he first suggested that only through such a breakup could bankers reclaim public trust.

“ ‘My word is my bond’ are old words,” he said dryly as London’s banking elite tucked into their filet mignon dinners. “ ‘My word is my C.D.O.-squared’ will never catch on,” he added, using the abbreviation for collateralized debt obligation, one of the financial instruments that were blamed for precipitating the financial crisis.

Since that speech, Mr. King has become a cult hero of sorts to many academics and others who advocate even harsher measures to keep banks on the straight and narrow.

One who has had his ear is Laurence J. Kotlikoff, a professor at Boston University who wants all financial institutions — from hedge funds to private equity funds as well as investment and commercial banks — to reconstitute themselves as mutual funds, meaning they would not be allowed to borrow to increase the size of their investments. The goal would be to prevent the types of debt-fueled bets that had such dire consequences.

That Mr. King would just about endorse such a proposal for the entire financial industry — he referred to Mr. Kotlikoff twice in his testimony on Tuesday — suggests that he may be inclined to push further than Mr. Obama.

“He is interested in this idea,” said Mr. Kotlikoff, who presented his idea to Bank of England officials last November and says he will do so again next month. “And he understands the depth of the problem.”

Never miss a story

Choose the plan that's right for you.
Digital access or digital and print delivery.